Commentary

Keep Existing Tax Cuts but Freeze New Ones

January 28, 2002|WILLIAM G. GALE and PETER ORSZAG | William G. Gale and Peter Orszag are senior fellows at the Brookings Institution, a nonpartisan think tank based in Washington.

Before Sept. 11, the signature achievement of the Bush administration was a tax cut that phases in slowly and runs through 2010. Now, since the terrorist attacks and the recession, some Democrats in Congress want to freeze some of the future cuts. Republicans say that would hurt the economy and want to make the cuts permanent.

How about a simple compromise: Make permanent the tax cuts that are already in place, but postpone the others until they are affordable.

Specifically, any tax cuts not yet in effect should be frozen until the projected 10-year budget surplus outside of Social Security and Medicare grows to be at least as large (relative to the economy) as it was when the tax cut passed. Since about half of the cuts are already in effect, this would give each side half of what it wants.

For several years, lawmakers on both sides of the aisle promised not to use the Social Security and Medicare surpluses to finance other programs or tax cuts. Last May, just before the tax cut was passed, the 10-year projected surplus outside of Social Security and Medicare was $2.7 trillion.

Given this projection, Congress scaled back President Bush's proposal, partially by ending the tax cuts in 2010. Even after the tax cut, Congress preserved a $1-trillion surplus outside Social Security and Medicare.

Eight months later, the surplus outside Social Security and Medicare has been replaced by a deficit of about $1 trillion. The tax cuts plainly are not as affordable now.

If the tax cuts become affordable again, we can meet our military and social priorities and enjoy the tax cuts at the same time.

But if the surplus does not recover, freezing future tax cuts would have several benefits. To the extent the restored funds were spent on social programs, the country could better meet needs in such areas as health care and child care. The rest of the restored revenue would reduce future budget deficits.

Federal Reserve Chairman Alan Greenspan has repeatedly expressed concern that projected deficits were propping up interest rates and hurting the economy, so restoring longer-term fiscal discipline would help to spur the economy now.

Administration officials worry that freezing future cuts would stop people from spending or investing. Yet evidence shows that last summer, Americans mostly did not spend even the $300 or $600 rebate they received, much less the ones they were projected to get in future years.

Economic research suggests that people tend not to spend tax cuts prospectively; they wait until the money is in their pockets. Our proposal would make the already implemented tax cuts permanent, which should raise their perceived value to households.

One other element lurks in the background. The tax cuts that have taken effect benefit households across much of the income spectrum. But most of the future tax cuts go to the highest-income households.

Freezing the future tax cuts until they are affordable while also making the existing tax cuts permanent would offer a little to both sides. It's a true middle ground on the budget, and it would help clarify our real choices ahead.